Fixing Capitalism

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California Bank” by waltarrrrr is licensed under CC BY-NC-ND 2.0

There’s a lot of talk these days about fixing capitalism.   However, there’s a problem with much of it—there are so many things to fix that doing them all seems a daunting task.  The point of view here is simpler.  There are a great many things that aren’t happening, because capitalism just doesn’t do them—and we should make sure those get done.

At its source this issue comes from being force-fed with the wildly radical idea that the private sector—capitalism—will solve all problems by itself.  So even when we realize that capitalism needs to be fixed, we can be overly concerned with all the patches.

However, even Adam Smith had no delusions about the limitations of capitalism.  As he pointed out:

  1. The private sector will not police itself.

On the contrary it will do everything possible to corrupt the free market with monopolies and government influence: “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”  We’re used to hearing “private sector” and “free market” used almost as synonyms.   In fact, as Smith recognized, the free market is an ideal that can only be achieved when government holds the private sector accountable.

  1. The private sector will not provide the environment for its own success.

Smith even advocated a government program of universal literacy, quite a stretch for the eighteenth century and a pointer for us today.  This is a serious matter, because it shows how dangerous it is to punt everything to the private sector.

  1. Much of what is needed for a successful society is simply out of scope for the private sector.

Capitalism will not provide any service where there is no competitive advantage in doing it.  Public health and welfare, environmental questions, basic science, etc. are all out of scope.

Fixing capitalism strictly speaking deals only with the first category.  No amount of fixing is going to make capitalism deal with the rest.  Those issues are ours to solve.

It’s instructive to think about needs in each category.

 

  1. Policing the private sector

Monopolies are still with us and have become an increasing problem due to technology changes and weakened anti-trust enforcement.  The same is also true of corruption due to business influence on government.  These days no one even apologizes for it.

This is particularly true in the financial sector where banking, for example, has evolved into speculative gambling with losses covered by the FDIC.  You can even argue that the financial sector overall has evolved in directions that make it predatory on productive business.  After decades of Republican-inspired hands-off attitudes toward business, there is no shortage of serious issues.  However fixing all of them makes progress look far away.

Taking a step back, there is a single biggest problem:  legal tax evasion.  This is a gating item for so much progress that it just has to be dealt with.  Even before Trump’s tax cuts (and despite nominal tax rates), American companies paid the lowest effective taxes as a percent of income of any developed country.  That was largely a result of multinationals’ ability to move income to tax shelter countries—reducing rates or hiding income entirely.  Apple is only one egregious case.  The tax cuts made matters worse with drastically-reduced business rates, arcane rule changes for overseas income, and the new pass-through income treatment.  That pumped up the deficit—thereby hobbling government’s ability to respond to the serious sins of omission in categories 2 & 3.

What’s more, despite the insistent propaganda, taxes are actually not a primary issue for American competitiveness:

– Many studies have shown that in most industries today business profit levels reflect monopoly power to set prices well above historic levels of margin.  That’s a trend we can expect to continue.  In other words, businesses have considerable financial room to pay taxes.

– Further, in actual fact the savings from the tax cuts went primarily into stock buybacks.  That is, companies decided the best thing to do with the tax cut money was to give it back to their investors in higher stock prices.

Conclusion:   Get the private sector (particularly large multinationals) and its investors to pay taxes.  Then work through the rest.

 

  1. Providing the environment for economic success

If taxes aren’t the issue, what is?  As we’ve noted here before, what makes for success is the technological advantage that has kept us in many areas on top of the heap.  That supports both our standard of living and our military strength.

Our technical dominance is based on three factors:

i. The dynamism of our economic system in generating new products and technologies.

ii. Broadly-based government support of research and education

iii. Remaining the preferred destination for entrepreneurs and other ambitious people from everywhere to realize their dreams

Let’s look at the current status of all three:

i. Unchallenged influence of big companies on government has favored established companies over new entrants. In part this is an anti-trust enforcement issue, but it has many other aspects.  The demise of net neutrality is one highly-visible example.

On this issue the interest of big business is strongly opposed to what makes for long-term national success.

ii. The administration is actively hostile toward science, government-sponsored research, and broad-based education. This is shown in purging of scientists from government agencies and restricting their influence on public policy.  One obvious example is in climate change.  Also the new tax law specifically punished major research universities with a targeted tax.

Public investment in research had a major role in the prosperity of the 1950’s and 60’s and kicked off the opportunities of internet today.  The same kind of public investment has remade China as a technology powerhouse.  But our dedication to research has eroded over time:

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Instead we’re waiting for the private sector to do the job, which by definition means catch-up.

The story for education is similar.   In the 1950’s and 60’s we were expanding educational opportunities to whole classes of people who had never before had the chance.   Now we rank far down on the list for upward mobility.  Sudent loan debt tells the same story, and that’s only about the people DID go to college, not about the ones who were deterred by cost and DIDN’T.  Finally, educational funding in the states has never recovered from the 2008 crash.

It’s worth mentioning in passing that the value of research is not only for international competitiveness.  Basic research is part of the global project of raising human standards of living. Even when one worries about national competitiveness, progress is generally so international that openness is the ante for remaining at the forefront of progress.  Current policy to restrict international participation of US scientists weakens the country in the name of national security.

iii.  As a final point we need to emphasize the critical role that foreigners and their children are playing in maintaining our national strengths.  Many studies have shown their role both in starting new companies and in supplying the technical underpinning that makes for success.  As Steve Bannon noted (for his own purposes) such people represent more than half of Silicon Valley activity.  Google (cofounded by a foreigner) and Apple (by the son of a foreigner) are only the most obvious examples.

The current xenophobic backlash is wildly off-target.  Particularly with the weakened support for research and education, those are the people keeping our place in the sun.

Conclusions:

– This area has got to be fixed or we risk losing our standard of living and dominant role.  These traditional values are as important as ever for US success.   It we’re worried about competing with Chinese, this is where the battle will be lost or won.

– If we can get our act together, items i and iii should remain as our advantages going forward.  So we shouldn’t be defeatist about a future that is in our hands.

 

  1. Spending for the common good

This has been a bastard child for so many decades now, that there is much that needs to be caught up.  Here is one short list:

– Infrastructure (Much discussed, but with more sides to it than you might think.  See here for a good overview.)

– Climate change (Evidence has become incontrovertible, but we still need a real plan.)

– Health care (Needed not only as a benefit but also as an enabler for equal opportunity.)

– Opioid crisis (Much discussed, but with radically inadequate funding)

– Environmental protection (Not a luxury)

– Transitional assistance (Helping people through changes—from technology, globalization, etc.)

There is enough essential work here to pose a major challenge for government.  We need to confront the unmet needs of the society, then we need concrete plans, and finally we need to manage major operations with competence and integrity.  Despite the propaganda there is nothing unusual about effective, government-sponsored work.  However as with any other enterprises, this needs to be scrupulously well-run.  Just because good people are running it doesn’t mean there is less risk of corruption.  We have to get serious about public enterprise.

That means we have to get past the idea that there is something intrinsically wrong about working for the public good.  That’s after all nothing more than the other side of the “private sector will solve everything” coin.  We live with the continued juxtaposition of vast under-employment (3.7% unemployment doesn’t change the good union jobs replaced by Walmart) together with vast unmet needs that the private sector won’t address.  We’ve got to take the initiative to match one with the other.  This is not “make work”.  It’s essential work that isn’t getting done, because the private sector won’t do it.

Until we take that initiative, it’s hard to assess where we are as a society.  Public enterprise helps in many ways.  It helps with inequality and the middle class.  It helps with leverage for workers and standards for employment.  Many public sector jobs of their nature will be hard to outsource.  It makes no sense to talk about abstractions such as Universal Basic Income until we see how things shake out in a fully-functional economy.  The future may be less strange or scary than it seems.

Conclusion:   We need to create the full-scale machinery for government service to do what the private sector won’t.

 

It’s always hard to foresee the future.  I remember when I was in high school, Prince Philip gave a commencement address at UCLA in which he spoke (as world expert!) about leisure.  Already then he was thinking that machines would take over work, leaving as us all to spend the rest of our lives at the beach.

That’s certainly not what happened, but there’s still something to be said for the positive spin.  Historically technology and even globalization have been good for living standards, except where societies have chosen to deny the benefits to large segments of their populations.  Both domestically and internationally we have every opportunity to do this right.  We can either organize our economy–and the world order–so that all can benefit, or we can go down in flames of our own making.

The World We’re Making

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“STATUE OF LIBERTY” by airlines470 licensed under CC BY-SA 2.0

The first Democratic debate began with a question to Warren about the economy: “Since most Americans think the economy is doing fine, why do you need all those plans for change?”  She responded by pointing out that the “great” economy was primarily benefiting only a lucky few.

Even that, however, understates the issue.  It’s not just that unemployment rates don’t tell the whole story about what it means to be working for a living.  It’s that there is so much run amok with the direction of the country that the unemployment rate doesn’t begin to stand-in for the strength of the economy or the well-being of the country overall.

For that we need to pull together many strands and formulate a picture what it would mean to have four more years of Trump—the kind of world we are making.  This note attempts to make a start.  We can be explicit about many things.  Our decline from the confident image of the Statue of Liberty was clear from early on, but now we have more specifics.  We should leave no doubt about the risks we run.

In doing this, one goal is to avoid what I felt was a problem with the Clinton campaign.  Trump kept talking about change, but we didn’t get across the danger in those changes: what they would mean for ordinary daily life, for the environment, for the courts, for democracy in America.  Who’s to say if that would have made a difference, but many people were certainly surprised by what they got.  If nothing else, it would have called out the risk of non-voting.

What follows is an outline with a few supporting points and references.  As noted this is a start.

  1. Climate change continues unabated

More unprecedented floods, hurricanes, temperatures, etc.

By leaving the Paris agreement we broke the international unanimity that was the best chance for progress.

               Each lost year is time we won’t get back

  1. Back to the 19th century on woman’s rights

Roes vs Wade hangs by the thread of Roberts’ desire for Court legitimacy.

One more Supreme Court vacancy, and we all live in Alabama.

  1. Loss of American technological superiority

Disdain for science and technology in government

Non-support of research and education

Ignoring climate change technologies

Choosing big, established companies over innovators (Net Neutrality)

Xenophobia and racism encourage entrepreneurs to go elsewhere

=> Lower standard of living

=> Real threat to our military security

  1. Erosion of opportunities for middle class life

Education—weakening of public education and more generations in debt

Attacks on unions

Healthcare at issue—ACA hobbled with no other proposal in view

Continued declines in good jobs for people without degrees

No recognition of the problems created by technology change

Cutting the safety net—If you don’t succeed you’re a loser

  1. Nuclear proliferation and risk of nuclear terrorism

Encouraging nuclear proliferation by statements and actions (N. Korea vs Iran)

More players means more chance of theft or sale

Belligerence normalizes nuclear weapons

  1. A population divided against itself

Conflicts stoked between races, ethnic groups, cultures

No interest in racial justice—to the detriment of all

Cruel and intentionally divisive Immigration policy

  1. A world filled with senseless conflict

Major hit to both security and prosperity

Trade wars instead of alliances and international norms

New arms race already announced

Policy rooted in weakness—from fighting on all fronts

Conflict as the first choice— “Trade wars are easy.”

Other wars too?

  1. Weakened environmental and other standards

Air and water

Workplace safety

Food safety

  1. Bubble economy based on debt

Good times prolonged by deficit-funded stimulus

Proven recipe for cycles of boom and bust (back to the 19th century here too)

No Republican history of help during downturns

  1. Undermining of democracy in the US

Increasing government by fiat (“executive order”)

Restriction of voting rights

Politicization of the Justice Department

=> Democracy is not a luxury—it made us what we are.

 

Weakness and Strength

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“King of Hearts” by Duong Vu licensed under CC BY-NC 4.0

We’ve talked here before about effects of bullying.  This time we want to be even more basic—weakness and strength.

If you want to get something done, it’s important to get others behind you.   In almost any task or context, few people are able simply to impose their will.  Building alliances is the means to power—for individuals and for countries.

There was a time after the second world war when the US, as last unscathed power, could do whatever it wanted.  That’s of course the era Trump recalls with MAGA.  But we’re no longer in that world, and we do ourselves no favor by pretending it’s still true.

Krugman had a recent NYTimes piece talking about the limits to our power in the trade wars.  However to my mind he didn’t go far enough with his argument.  It’s true that our power is limited, but we also refuse to think seriously about how to get things done.

China is of course the case in point.  Despite Trump’s initial declaration that “trade wars are easy”, this one has been up and down for many months with constant chest-beating and accusations of evil.  There is still no clear idea of the timetable or eventual conclusion.  One thing that is certainly true is that there is already a legacy of hostility and suspicion on both sides—with consequences that will survive any deal.

That situation is not a fact of life, it’s a fact of weakness.  We represent 18% of China exports, and by going it alone that’s all the leverage we’ve got.  The EU represents another 18% with essentially the same grievances.  Normal behavior is to ally our interests and get to the conclusion with overwhelming power.  The Business Roundtable of Corporate CEO’s recognized that from the beginning.   However, Trump wanted a special deal with his name on it, so he chose weakness instead of strength—leaving us all to live with it.

We can even go a step farther.  As a way of exercising power, international institutions are actually useful for this kind of problem.  That’s why, despite the “threats to our sovereignty” rhetoric, those institutions exist.

China is still classified as a developing country for the WTO. Everyone expected that to change, with new rules to be negotiated. That is where the US + EU leverage would normally be brought to bear.

And negotiation in that context has two more advantages:

1. First the negotiation becomes a matter of standards for international behavior, not a question of national honor. That keeps the focus on technical issues rather than face-saving.

2. It requires us to separate what are real matters for rules of commerce (open markets, intellectual property, conditions for labor) from whatever barriers we might want to place in the way of Chinese technological development.

That may sound like a limitation, but it is actually an advantage.  It makes us think about competition for what it is, rather than as something we can cure with a big stick.  There is plenty that we’re not doing to strengthen our own act.

The bottom line here is simple.  We have chosen to fight a trade war with China out of weakness.  That weakness has already had consequences in terms of relations between countries and will also be expressed in the terms of any final agreement.

We can be explicit about what that means.  We have chosen a path that will lead to less access to the Chinese market (already the biggest economy in the world) and more hostility between countries.  On that second point we have already announced a new arms race—which will cost both countries (and the rest of the world economy) dearly.

None of this has to be.   It’s weakness instead of strength.

The Tariff Tax

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As many economists have noted, tariffs are not a sneaky way to get free money from foreigners.  They are a tax paid by all of us in higher prices, and that’s exactly what has happened with the Trump tariffs to date.

Since a tariff is a tax, it’s worth thinking about what kind of a tax it is.  We’ll be specific.

For this note we’ll restrict ourselves to the two biggest ones:  the new Chinese tariff of 25% on $250 B of annual inputs and the new Mexican tariffs, scheduled (as Trump says) to reach 25% on all Mexican imports ($346 B annually) by October.  This costs a total of .25 x ($250 B + $346 B) = $149 B annually.

At first glance this doesn’t seem too bad, since aggregate annual income in the US is $13T, and $149 B /$13 T is about 1%.  But that’s the wrong comparison.  The primary impact here is on prices, which means we’re talking about consumptionnot income.  This is like a sales tax.   Consumption is much more evenly distributed than income, so lower incomes pay more.

It is a truism that the rich spend less of their income, because they don’t have to.  But in fact we can be specific.  Even if we throw out the highest 5% of incomes, the income distribution in this country is more than 3 times more inequitable than the consumption distribution.  What’s more, the US Bureau of Labor Statistics publishes a breakdown of consumption spending by decile segments of US income.  That is, for each 10% segment of the population—ordered by income—they give a percentage of total consumption spending.  These ten slowly-increasing percent values give a quantitative picture of what it means to say the rich spend less of their income:

4.1, 4.5, 6.1, 7.0, 7.8, 9.0, 10.5, 12.1, 15.1, 23.7

Going back to the $149 B of tariffs, this tells us how those tariff costs are allocated to the different segments of the population:  4.1 % to the lowest tenth of income, 4.5 % to the next tenth, and so forth.  Further, since the total number of households in the country is 141 million, we can even say something about how much households in each segment will actually have to pay.  For the lowest segment this is

$149 B x (0.04) / 14.1 M = $433

The calculation is the same for each segment, using the percent values just listed.  In addition the Labor Statistics figures also include the average income level associated with each population segment.  That lets us directly compare Trump’s much-touted tax cuts with tariff costs.  Putting it all together we get the following chart

Population segment Percent of consumption Average income Tariff cost Tax cut
1 4.1 $6,000 $433 0
2 4.5 $16,000 $475 $50
3 6.1 $25,000 $644 $180
4 7.0 $35,000 $738 $360
5 7.8 $45,000 $824 $570
6 9.0 $60,000 $951 $870
7 10.5 $75,000 $1110 $1310 (combined in source)
8 12.1 $100,000 $1268
9 15.1 $130,000 $1596 Not in source
10 23.7 $250,000 $2504 Not in source

What we see is that the Chinese and Mexican tariffs alone overwhelm the Trump tax cuts for 60% of the US population (and come close for another 20%).

Conclusion:  Tariffs are a serious and regressive tax.  Since they are also an expensive and uncertain way to create jobs (at $800-900K each), this is no silver bullet.  And that’s before we even think about retaliation.

For Sanity on China

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What are our stated objectives with China?

  • We want to bring them into the world economic system on appropriate terms of fair play.
  • We want access to their markets according to those rules of fair play.
  • We want protection for our businesses and workers, also according to those rules of fair play.

Those are perfectly normal and achievable objectives.  We can be specific about how to get there, and the probability of success is high.

What are our actual objectives in the trade war?

Trump has been clear about this in both words and deeds.  Our trade war is to assure that China will never be able to challenge our technological, economic, and military dominance.

Those are not the same as the stated objectives (although the press seems confused about the difference).  They are objectives for a real war.  And if you’re going to fight a real war—with bullets or with tariffs—you had better be sure you’re going to win, or the results won’t be pretty.

Problem #1:  We don’t run the world.  We are 18% or Chinese exports, same as the EU.  We’ve gone out of the way not to have an alliance with the EU on this issue.  (It’s worth noting that the EU already has a far lower balance of payments deficit with China than we do.)  The Chinese domestic economy is already larger than ours.  We can inflict pain, but we can’t put them out of business.

Problem #2:  China’s technological and military strength is not just because they’re stealing from us.  That genie is already out of the bottle, and it is an imperialist delusion to believe we can keep them poor and dumb.

Problem #3:  We’ve converted an issue of international good behavior into a matter of domination.  Without boots on the ground there’s no way in hell we’re going to enforce an agreement of subjugation.  (The distinction is not a gray area—we’re either thinking about rules we’d be willing to apply to ourselves or not.)

What’s going to happen?

The Chinese will go build their (very large) part of the world without us.   We will have no effective access to their markets or their technology (already today technology is a two-way street).  We’ll be back in a cold war with all that entails in risk, mutual hostility, military spending, and stunted world growth.

What should we do?

  1. The first step is to cool the chest-beating jingoism. (China is in fact a mixed bag for the US economy.) That way we can at least recognize the difference between the two types of objectives.  It’s the only way to behave rationally.
  2. If what we want is a correct and viable world order, then that means we need an alliance supporting our view. Ultimately this should end up in the WTO, but a first step is to codify what we want and assemble wide support.  That will add both carrot and stick to achieve our objectives.  The Business Roundtable of corporate CEO’s was explicit about this from the beginning.
  3. History shows that the best way to avoid war is mutual commerce. That means establishing rules we can all abide by.
  4. If we’re worried that the Chinese are going to take over anyway, then the best thing to do is to recognize and play to our strengths. Overall the odds are well in our favor.   The fact is that we’ve been here before.  Not so many years ago the perceived technology threat was Japan.  In China, Xi’s thirst for control makes him an enemy of what made for China’s success.

History is full of disastrous, inconclusive wars that no one wins.  Trade wars too.  We’re not so weak that we have to blunder our way into this one.

Losing by Bullying in China and Elsewhere

Most of us choose not to run our lives as bullies.  That’s not because we’re all so nice; it’s because being a bully is usually a bad option.  For one thing it’s precarious—the bully loses everything as soon as he’s not top dog.  And what’s worse is that it precludes other ways of getting things done.  The bully has nothing to offer but bluster.

The US has been the predominant world power since World War II, but we’ve generally chosen not to play the bully.  Instead we’ve used international institutions to enshrine our views as a kind of international rule of law.  That has been a very successful enterprise—no one wants to be odd man out.  And after 50 years we remain both the military and the economic powerhouse.  (How that filters down to the well-being of the population is another story.)

Recently however we’ve made the all-too-common mistake of believing our own propaganda.  We’re just too nice, and in our beneficence everyone is stealing from us.  For example NATO—which exists to make sure a Russian WW III is fought in Europe and not here—is now a case of wasting money to defend ungrateful allies.  The time has come to step out from behind the curtain and take all that we can get.

How have we been doing as a bully?  Let’s look at a few examples:

Iran

In Iran we’ve decided to take off the kid gloves and go for everything short of war.  The result thus far has been to strengthen the hard-liners in the government and to unite the population behind hatred of the US.  Initial steps have begun to resume nuclear weapons development—an effort that has strong support in the population as a whole.

Regime change remains unlikely, and even if it happens, it won’t be pro-US.  As for nuclear weapons, we’ve made North Korea a proof-positive of their value.

Venezuela

Trump administration high-handedness has intensified the ever-present fear of US domination—even among Maduro’s opponents.  That played a big part in the failure of the Guaidó uprising.

Arbitrary exercise of power makes us weaker.

China

This is currently the most consequential case.  We have legitimate grievances with China, but the situation is not so black and white, and it matters how we play it.

Our bullying approach began with tariffs before negotiation.  Then we chose to violate the our own trade agreements to go for an exclusive deal to benefit only us.  And we are unabashedly using the process to prevent China from challenging our dominance.  Finally we’re consumed with a feverish China bashing that has nothing with the reality of China’s effect on the US economywhich has many positives, and the negative effects don’t begin to compete with what we’ve done to ourselves.

There are two points worth emphasizing:

  1. The US represents 18% of Chinese exports, as does the EU. By making this an exclusive deal we lost half our leverage. That was a “get out of jail free” card for the Chinese. They didn’t have to worry about dividing the West, because we did it for them. (Not the only example of giving China exactly what they want.)
  2. We have dispensed with the idea that this is about international rules for fair trade. Instead this is strictly about what our national leverage can get us.  That’s not a great basis for compliance (particularly given history), and there are many ways that trade deals can fail to deliver.   Further, by setting arbitrary tariffs we’re striking a blow for protectionism, not open markets.  That’s the last thing we should be doing when a primary goal is access to a Chinese economy that is already larger than ours and growing faster.

The is another way to do this, and it was waiting to happen.  Within the WTO China is still classified as a developing country.  All parties recognize that needs to be renegotiated, which would have happened regardless of who was President.  The hand we were dealt was better leverage, better compliance, and no trade war.

There’s another way to look at this.  The following chart shows the kinds of items China exports to the US.

chinese_exports

It’s not just cheap widgets.  It’s the computer equipment that runs the software that is the basis for our economic strength.  The worst thing China could do to us is stop its exports.  So what do we really want?  In some order, we want access to the Chinese market, we want a say in how China competes in the rest of the world, and we want to address intellectual property theft.

We have good means of addressing all of these, but bullying China isn’t one of them.  A trade war is counterproductive for the first two, which is why we created the WTO.  For the third, we now have a common interest, and it’s worth noting that Chinese hacking has gone way up, since Trump declared economic war.

Bullying behavior may give a rush of power, but it’s no better for countries than for people.  It makes the world worsemost of all for US!

More To Say About China

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This piece is a little broader in scope that our past posts about China.  That seems useful, since war-mongering in press coverage of China has put us all in blinders.  We’re not claiming here that the Chinese are angels, but there is a lot more to the story that needs to be discussed.

We start with a couple of basic points, of interest regardless of whether we consider China friend or foe:

  1. China is now the world’s biggest economy and is continuing to grow rapidly. Further its population is more than four times the US.  That has many consequences worth thinking about.
  2. China has built itself up from nothing to a world class challenger in many areas. This is not just—or even primarily—a case of “stealing from us”. It is imperative that we understand their example and what we can learn from it.

On the first point, it should be noted to begin with that while the Chinese economy is the biggest in the world, the country is so big that its per capita income is well-below Mexico.  A rising standard of living in China could drive growth in the rest of the world for quite some time.

That is a dramatic turnaround in what China means to the rest of the world.  It is also the reason why virtually everyone expects China’s trade relations to be renegotiated.  Opening China has moved from a largely theoretical matter (because there just wasn’t that much to be sold) to become the primary issue.

This is the time for negotiation, but it’s also a window of opportunity we can easily miss.  In this, as we’ve noted before, a unilateral trade war is actually counter-productive. We’re defending protectionism, when the primary issue is open access to the Chinese market!  Further by insisting on a bilateral deal, we’re substantially reducing the leverage needed to make the deal a success.  The Business Roundtable of corporate CEO’s said as much prior to the start of current negotiations.  This isn’t about trade deficits; it’s about worldwide rules of fair trade going forward.

Trade negotiation, however, is not the only issue here.  US businesses have long had the luxury of focusing on the domestic market.   Economies of scale will now demand a less parochial view.  An obvious example is loosening of fuel economy standards.  That’s a concession to our automobile industry for the domestic market that will hurt international competitiveness.  Another example is 5G mobile equipment.  US vendors are behind the curve, because the domestic market has been fractured and slow-moving.

We are not doing our economy a favor by granting special favors (including tariffs) to domestic businesses.  That’s just perpetuating the idea that winning here is all it takes.  (Tariffs are also an unreliable and inefficient way of producing jobs.)

As for what we can learn from China, we give a few examples

– Government-sponsored R&D pays big benefits.  That is the single biggest contributor to the Chinese success.   They have created a world-class technological empire out of almost nothing.  Even the much-lamented Chinese technology theft is a non-trivial (if nefarious) accomplishment.  How many companies do a good job managing transitions of responsibility even for their own software?

We used to care about the government role in research too.  It was assumed in the good old days of the 50’s and 60’s. Now we have not only cut back on government R&D (Trump’s latest budget is a recent example), but with the current anti-science nostalgia we’re not even sure we want much to do with scientific progress.

– Education is an imperative.  It’s people who make for national success and we need them to be prepared for the jobs that will defend our national standard of living.  China has been ready to spend the money to make it happen.

– We should want to drive up the value chain.  Despite past history, the Chinese understand perfectly that price-competitive businesses are not the way to go.   Real wealth comes from dominant industries with the power to sell on content instead of price.  That’s what technology can deliver.  It’s simply not in the cards to believe past successes will just revive.

– All businesses need to embrace technology for success.  Even in the cost-sensitive outsourcing business, ease of interworking was an important factor in Chinese success.

– Finally (and paradoxically) a dynamic, decentralized economy is a real plus.  This may seem surprising in a list of lessons from China, but it’s strangely true.  The major impetus that kicked off the Chinese economic miracle was an accidental liberalization.  As a small opening, Chinese municipalities were allowed to run independent businesses once they reached their nationally-set production goals.  As it happened, these independent businesses took off and eventually marginalized the state-run enterprises.  Many morphed into successful private companies.  (Xi is now attempting to put that genie back in the bottle, with reemphasized state enterprises.)

We should never underestimate the value of the dynamism of the US economy.  But we had better be careful to understand what has really worked for us.  There has always been an important government role, and diversity mattered too.  In the Chinese example, success was only possible because government provided the environment, particularly education and infrastructure, for the businesses to grow.  That’s precisely what worked for us establish US dominance in the post-war years.   In general, prosperity requires both the environment and the opportunity to achieve success.

 

All that being said, what can we say about dealing with China?  A few guidelines:

We are misled if we think “enemy” is all we need to know.  China is an important factor for both good and bad in the world economy.  They were an important help in the efforts that prevented a depression in 2008.  They can be a major locomotive in the world economy going forward.  They contribute to the worldwide development of science and technology—which makes us all richer.  They recognize the importance of climate change.  It is our task to make that all work for us.

To get there we need to treat the Chinese like any other adversary—we should deal with them from strength and look for mutual advantages.

It is not productive simply to dictate, with the idea that we can shut them down by denying them access to our market.  We represent 18% of their export market and much less of their total economy.  That’s plenty to cause trouble, but not enough to dictate, and in any case real pain would hurt us as well.  Further, if we want success in their market, there has to be ongoing mutual self-interest—no signed document will do it.   And there’s a historical side of this as well:  China endured some of the worst of western imperialism in the nineteenth and early twentieth centuries.  That memory lingers, and we are not served by recalling it with our behavior.  Mutual advantage is much better than antagonistic isolation.

We need to extend the rules for fairness in international commerce through the WTO.  As noted earlier all parties recognize this has to happen, and we have historically led such initiatives.  We have twice the leverage in cooperating with the EU (also 18% of Chinese exports), and we avoid the hypocrisy of endorsing protectionism in the argument for opening of their markets.

Matters such as intellectual property protection and theft should be solvable problems, in part because the Chinese now have much to defend as well.  It’s not for nothing that Huawei is well ahead of the curve in 5G development.   Chinese universities are now high on the list of international institutions (even though Western ones still have cachet in China!), and the Chinese are acquiring patents like everyone else.  It’s also true, if seldom noted, that Chinese computer hacking decreased significantly by the end of the Obama years and went way up when Trump declared economic war.

The military installations in the South China Sea are a serious problem, but the fact is that the great majority of Chinese imports and exports pass that way—so it’s not surprising they’re worried about it.  We make that worry all the greater by declaring that it is legitimate to use all resources at our disposal to get the Chinese to do what we want.  The only real solution is some kind of freedom of the seas regional agreement that all parties can have confidence in.

Human rights violations are also important, and we have to keep those issues alive.  It’s hard to know how far we’ll be able to get.  The one thing you can say is that we shouldn’t be too quick to use Xi a stand-in for China as a whole.  We’ve already noted Xi is a throw-back (a “princeling” heir to the Maoist past), so perhaps there is hope for better later.  There are many conclusions to be drawn about us if you take Trump as a stand-in for everything American.

In the end the point is to treat China like any other independent nation.  China as “enemy” has real roots, but also large doses of domestic politics (China has been a convenient excuse for our own misdeeds) and “yellow peril” racism.  China needs to work properly in the international system of trade and ideally also in international security agreements.  Any efforts to avoid a new set of arms races will have to involve them.

Vigilance is fine, but there is at least the potential of much to build on.

Prosperity in Today’s Economy

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The title of this article sounds rather ordinary, but in fact there’s more to say than you might expect.   There aren’t a lot of new facts here, but we bring together several strands of argument that don’t tend to be followed to conclusion.  It’s useful to think step-by-step about prosperity today and going forward.

  1. Our national standing today is largely determined by technology.

There are many aspects to this.  The most obvious one is the role of high-tech companies in the economy.  The NYTimes had an article a few months ago (on the occasion of Apple’s becoming the first $1 T company) with graphic displays showing the size of Apple (as well as Google, Microsoft, Amazon, and many others) in the US economy.  The dominance of high-tech is unmistakable. That’s what supports our standard of living and always has. Railroads, steel, automobiles were all high-tech in their day.  (Note this is not saying that Google or Facebook are angels, it’s our national strength in technology that matters.)

It is only because we are on top of that heap that we have the money that supports the rest of the economy.  That includes much of small business and service industries.  It is from the strength of our competitive economic position that we can pay for the non-competitive industries we choose to support.  The aluminum and steel tariffs are being paid by us from the industries that don’t need them.  To state this somewhat differently—we are not going to build a dominant economy by selling each other stuff anyone can make at artificially high prices.

It’s also worth pointing out, given all the discussions of the military budget, that the technology argument applies in spades for the military.  Building new aircraft carriers is not going to make us safe.  One only has to think, theoretically of course, about the effect of a North Korean virus disabling the military’s command and control.  From the chart below, it is obvious that our level of military spending ought to quash everyone else hands down if money were the only object.  But it’s not doing the job, because that’s not the game anymore.  And it’s not just AI, it’s across the board.

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What all this means is that the people who support our technology position are critical resources who matter to all of us.

This is a lot less elitist than it sounds, because it’s not saying we shouldn’t care about or value everyone else (more on that later).   The point is that we shouldn’t be spending our time worrying about who is or isn’t supplanting whom.  Our success depends on nurturing and exploiting the best and the brightest—at least for these skills—and we had better spend our time trying to find them and encourage them, regardless of race, gender, or sexual orientation.  And if foreigners choose to come here and establish successful startup companies—mostly in high tech—we should be happy they do.  It is a major strength of the US economy that people find the US to be the best place to realize their ambitions.  We erode that strength at our peril.

Anger at elite technologists may be natural, but they are the wrong targets.  Their effect on the rest of us is positive.  What we need to avoid is a two-tiered society of haves and have-nots, as we’ll discuss later.

  1. Businesses today are different from the past in important ways.

Since we’ve identified the key role played by the tech sector, it’s worth thinking about what kind of businesses those are.  So let’s take a quick look at Google, Apple, Amazon, Microsoft, and Facebook.

– A first point to notice is that they are all some form of monopoly.  This is not surprising as they are all (even Amazon and Apple) essentially software companies.  Software businesses invite monopoly, because costs of production are minimal. In such cases, research and development costs become primary, and the company with largest market share can afford to offer products with more features than a smaller competitor can.  As automation continues, particularly with AI, similar arguments will apply to much of the rest of the economy.

Managing monopolies is a serious issue:

Monopolies squelch competition.   It is imperative for our success that established companies can’t limit the innovative power of new entrants.  That has been our historical advantage over foreign competitors and is a major factor in any discussion of how we deal with the rise of China.  This is not just a problem with Google, etc.  The demise of Net Neutrality is a classic case of giving in to established players, in this case the major telecom carriers.

Monopolies take more than their share of our money.  Monopoly power limits price sensitivity. Since the determining feature of competition is more often uniqueness more than price point, products are priced at what the market will bear—as with the iPhone or patented drugs.   Furthermore, through manipulation of assets including intellectual property, hi-tech monopolies have been tough to tax.   Apple’s success in this is legendary.   Their windfall from the recent corporate tax cuts is something to behold (and unnecessary as a spur to investment).  It is imperative we learn how to tax monopoly-level profits.

– Next, personal success in these companies requires a high-level of technical competence.   Amazon is obviously a case in point, with two completely different populations:  the mass of box fillers versus the corporate staff.  Note that technical competence is not just a matter for developers, but is also required for the many people in management, support, administration, and even sales.  As just noted, as automation proceeds, this trend will extend well outside of high-tech.

This represents the threat of a two-tiered society, as discussed earlier.  As a country this implies at the very least a basic responsibility for broad-based solid education and a livable minimum wage.

It should be emphasized that strengthening of education is required for both national success and personal prosperity.   Regardless of what advantages we have for staying on top of the heap, we cannot succeed if we don’t have the people to do it.

– Third, all of these business are intrinsically international.  With the growth of the world economy (and China in particular) economies of scale are such that we have to think in global terms.

– Finally our fourth and last comment for this section is about a different trend not limited to high-tech—the institutionalized irresponsibility of business.  It has become gospel that businesses have responsibility only to their investors, and all other considerations are more or less theft.  Businesses used to care about retirement, healthcare, training, even local charity.  But current reality is that if someone is going to care about those things, it’s out of the question for it to be them.

In addition, because of the sheer size of the country, the US more than anywhere else has to deal with the phenomenon of towns or regions where the economic base can just disappear. Company town are the obvious example. In an age of accelerating technology change, we can’t stop such things from happening.   And we can’t expect rescue to happen by all by itself.

However we emphasize this isn’t just about charity.  In the current state of affairs, the private sector is not be doing what’s necessary even to provide the environment for its own success.

That leads to the next topic—what do we need for national success?

  1. Our infrastructure problems mean more than we thought.

Infrastructure has to be thought of as whatever is necessary for national success and personal welfare.  I.e. much more than roads and bridges.  The educational system fits in this category as it is required for both personal and national success.  Declining upward mobility and the student loan crisis are two indications that there is a lot that needs to be done.

Support for theoretical research is in the same category.  It is precursor work for new technologies before they are ready for business. A point worth stressing it that it is not only the research itself that is important—research work assures that there will be a population ready to exploit new opportunities as they arise.

Continuing on, we list a few more significant infrastructure projects needing immediate attention.

– The American Society of Civil Engineers keeps a web site with a break down of national infrastructure requirements.  We currently rate a D+.

– To that we add the urgent needs of combatting climate change, which will be considerable, regardless of how the final plans work out.

– Healthcare is currently in flux with ACA under attack and nothing to replace it.

– Finally we have the general specter of a two-tiered society, with all the misery and threat of conflict that represents.  That too needs to be dealt with as a national problem, and there’s no one in this picture other than government to do it.

Government’s role in this picture is three-tiered:

i. Government needs to make sure everyone has the education and access to the opportunities to succeed.

ii. Government needs to support what is necessary for national infrastructure, much of which will not happen spontaneously in the private sector.

iii. Government needs to supply a last-line safety net for those who fall through the cracks.

This is a non-trivial task, and we emphasize that the biggest part of it is not charity.   We have a current mismatch between a dearth of good jobs and a growing backlog of infrastructure needs of all kinds.

From the point of view here our much-discussed infrastructure needs—back to the roads and bridges—have to be viewed as bellwethers.  The fact that we can’t deal even with roads and bridges means that we have a fundamental problem funding the common good, and we have to take that head on.

  1. There is a mismatch between the needs of our country and the forces that currently control it.

The governing ideology of this country is simple to summarize:  let the private sector do it and get out of the way.  All government regulation is bad, and taxes are just a brake on the private sector’s ability to make everything great.

The chief beneficiaries of this policy are the ultra-rich funders of the Republican Party, although the problem of money in politics (especially after Citizens United) transcends parties. In this enterprise Trump is largely a front man for the real forces running things.

For these people, with fortunes going back even into the nineteenth century, it’s natural to regard the country as a money-machine.  Taxes, regulations, and government services—except for the military—are deductions off the bottom line.

The problem with that view, even for them, is that it is the wrong model for the world we just described.  That set of policies would make sense in an extractive economy, where all that is necessary for success is a cadre of imported experts to arrange for pumping oil with purchased technology.  In that case you don’t need much from the national population in order to collect the proceeds.

That’s not our situation.  As described, we live in a technology-dominated world where the population must earn our national success.  For that world we’re currently going in the wrong direction.  Devaluing education, denying climate change, cutting research, encouraging xenophobia will get to us sooner than we’d like to think.  China is a formidable challenger.

However, it not so hard to be optimistic if we can just be serious about what needs to be done.  We have all the tools for success:  the money, the work to be done, even the means to avoid a two-tiered society.

The story is not complicated.  If we can return to exploiting our strengths, then we should be able to remain in the technological forefront for our chosen areas of focus.   If we can control the monopolies, then the associated margins in an expanding world economy should yield money enough (if we can collect it) to produce a workable society for everyone ready to participate.

There is certainly no shortage of work in the infrastructure area, and it needs all kinds of people.  In this respect the Green New Deal may be too glib in pinning everything on climate change, but their basic idea is correct.   If we play our cards right, the high technology future will provide the funds to support the infrastructure for its own success and for the prosperity of the nation.

We should not underestimate the job.  Careful and transparent planning is critical—defining exactly what needs to be done to support both the economy and the population.  And then determining how that work can be best supplied.

It should be emphasized is that we’re NOT talking about socializing away the free market economy.  If there’s one bad misconception that needs to be hammered down everywhere, it’s the idea that the private sector is magic for all problems.  We’ve just gone down a long list of things it’s not going to do.

Even Adam Smith was clear about this from the beginning.  The private sector is a participant in the public economy, but that economy will deliver the benefits of a free market only if #1 government keeps the private sector from corrupting the markets (e.g with monopolies and bribes) and #2 government provides the resources (e.g. education and other infrastructure) necessary for success.  That’s the definition of our job.

This will necessarily require a renewed focus on government and public service.  It’s interesting that a couple of recent mainstream books (Volker, Lewis) have recognized public service as an important issue.  In that respect “Green New Deal” isn’t a bad term:  we need to be as serious as Roosevelt’s brain trust in planning for the next stage for our country’s future.

This is a battle both old and new.   In Smith’s words, “The interest of [businessmen] is always in some respects different from, and even opposite to, that of the public …The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention.”  Wealth of Nations is only achieved when government does its job.